Mutual Fund News

Success is predicted by low fees, not historical returns

By ANDREW HALLAM

Wednesday, March 12, 2014

Every day, thousands of Canadians settle into chairs in front of financial advisers. Most people don't have an interest in the stock market. They know they should be investing in RRSPs, but they don't have the time or inclination to bother with individual stocks or ETFs. Instead, they trust an adviser to select investments for them. In most cases, they end up with a portfolio of mutual funds.

Let me tell you a secret. Many advisers overlook their firms' best products when building portfolios for clients. They dazzle investors with strong historical fund charts. But according to Morningstar, the lower the funds' expenses, the better the odds of future success. Index funds outperform most actively managed funds because indexes cost less.

Ted Gadsby was president and CEO of CIBCSecurities in 2001 when he published The Power of Index Funds: Canada's Best Kept Investment Secret.

Five years previously, CIBC had launched its series of indexes. Shortly after Mr. Gadsby's book release, CIBC raised expense ratios on their passive funds. Many Canadians cried foul. The bank's Canadian stock index costs 1.13 per cent per year. Its U.S. index charges 1.18 per cent. And the company's international index costs 1.23 per cent.

Such costs for indexes are sky high. But they're still far cheaper than CIBC's actively managed products. As of 2011, investors with more than $50,000 per index fund qualify for their premium fee rates, costing between 0.4 and 0.65 per cent. "The goal of our premium pricing offer is to give investors more product options at a very competitive price," says Steve Geist, president of CIBC Asset Management. "We wanted to provide solutions with pricing that was comparable to ETFs for clients who want to use passive strategies for part of their portfolio."

But buying index funds for just part of a portfolio makes little sense. It indicates that the investment professional can hand-pick funds in a pet category that will outperform the market. Studies prove that not even Morningstar's five-star rating systems can do so consistently. They admit that low fees, instead, are the most reliable predictor of success.

In theory, the aggregate returns of CIBC's index funds should outperform their active funds. They can be measured, head to head, in six broad equity categories: Canadian, U.S., International, European, Emerging and Asia Pacific equity.

During the past six months, CIBC's equity-exposed index funds outperformed their actively managed counterparts by 0.07 per cent. Of course, six months is hardly a time period worth measuring. They also outperformed during the past year, beating the active funds by 0.3 per cent. Their margin of victory extended to a total of 1.18 per cent over the past three years. Over the past five years, the indexes were 6.71 per cent ahead, and over the past decade, they would have likely outperformed by 11 per cent or more. Two of the actively managed funds don't have 10-year track records, including the U.S. equity fund.

Hats off, however, to CIBC's fixed-income managers. Their Global bond fund averaged 2.1 per cent per year for the decade, while their Canadian bond fund earned 4.5 per cent. Each outperformed CIBC's indexed counterparts, which averaged annual returns of 1.5 per cent and 4.2 per cent respectively.

Now here's a test for CIBC's fund investors. Should you select these bond funds based on their strong past performance? Or should you choose CIBC's lower-cost bond index funds instead? If you're opting for the actively managed products, you're ignoring the evidence. When it comes to choosing funds, costs matter more than anything else. Make it clear that you understand this the next time you sit with a financial adviser.